Fed Confusion; FOMC's Wrong-Footed Comments: Best of Kass

NEW YORK (TheStreet) -- Doug Kass of Seabreeze Partners is known for his accurate stock market calls and keen insights into the economy, which he shares with RealMoney Pro readers in his daily trading diary.

Among the posts this past week were entries about the market's view of the Fed and the Federal Open Market Committee's most recent rate-decision release.

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The Fed Is a Confused and Toothless Paper Tiger
Originally published on Friday, Nov. 1 at 7:29 a.m. EDT.

The market now sees the Fed as a confused and toothless paper tiger.

Whether this is bullish (as evidenced by eurodollar futures are at a recent high) or bearish (more volatility and less predictability lies ahead), we can't possibly know at this time.

I describe the market's view of the Fed as a toothless paper tiger based on the fact that the federal funds rate at year-end 2015 is being discounted to 62 basis points vs. the Fed's forecast of 1%.

As I described yesterday in "Happy Halloween From the Fed," I consider Wednesday's FOMC statement as a bunch of wrong-footed and low-quality gibberish.

Clearly, the Fed is now in a bind.

The dual mandate would suggest that current monetary policy would stay in place for a lengthy period of time (read: many years).

The more the Fed's balance sheet expands, however, the higher the amount of losses to the Treasury down the road. In its extreme, this could pose a risk to the Fed's independence.

This issue has been a talking point in academic and policy circles over the past two years -- even the International Monetary Fund cited this risk recently.

Let's review the confusing timeline of Fed tapering commentary in 2013:
  • On May 22, Humphrey Hawkins questioning Chairman Bernanke's "next few meetings" comment stopped the market's bull run, which had previously behaved as if the notion of tapering was so far out not to matter.
  • Bernanke's post-June 19 press conference led the markets to trade as though tapering were likely to begin in September. The S&P 500 lost 5% in four trading days, while the bond market suffered a brutal beating (as 10-year U.S. note yields rose from 2.05% to 2.95%).
  • Then Bernanke blinked. Financial conditions tightened as mortgage rates climbed. So, at the July 10 press conference after the NBER speech in Boston, the Chairman moved toward a very dovish stance, citing a weaker-than-forecast economy. No longer was the unemployment rate of 6.5% a trigger to policy -- there were conditions placed on the jobless rate. But, it seemed to markets that the message was that a September tapering was still on.
  • The Sept. 19 no-tapering meeting surprised the markets, with only Esther George dissenting.
  • It is clear that the Fed is confused and the markets view our monetary authorities as a paper tiger.

In the extreme, the Fed appears to be almost paralyzed.

In all likelihood, the economic data in the near term will be distorted and ambiguous.

There is simply not enough clean data for a confused Fed to make policy changes at the December meeting. A January tapering is also unlikely, as it coincides with another debt ceiling negotiation, and this Fed doesn't seem to be in the mood to upset the markets.

While the odds now favor a March start of tapering, a confused Fed is capable of anything.

And that lack of predictability is bearish.

At the time of original publication, Kass had no positions in the investments mentioned.


Happy Halloween From the Fed
Originally published on Thursday, Oct. 31 at 7:28 a.m. EDT.

Below are some statements from the Federal Open Market Committee's most recent rate-decision release:
  • "Labor market conditions have shown some further improvement."
  • "Activity continued to expand at moderate pace."
  • "Data suggest household spending and business investment advanced while housing slowed somewhat in recent months."
  • " The FOMC still expects growth to pick up from its recent pace and the unemployment rate to gradually decline toward levels Committee judges to be consistent with its dual mandate."

The FOMC introduced uncertainty into the markets in its surprisingly upbeat economic assessment/outlook, which didn't, as it did in September, mention tight financial conditions. Moreover, the failure to mention (with emphasis) the failure of fiscal policy suggested to market participants that the probability of a December 2013 tapering has not been abandoned.

The markets took the FOMC comments as hawkish.

In response:
  • U.S. dollar-Japanese yen traded above 98.60 post-Fed;
  • The 10-year yield was 2.47% prior to FOMC and moved up to 2.52% (reversed from down to up);
  • S&P futures are down 50 basis points on the day; and
  • S&P energy is down 1%.

My view is that the Fed's description of the domestic economy is wrong-footed. (Note: In the past, I have often pointed to the Fed's poor forecasting ability.) For example, the jobs market has deteriorated and has not improved, and business capital spending is weak.

Additionally, I would observe that the quality of the FOMC statements has eroded and that Fed policy has grown less predictable. (Yesterday's ambiguous statement is perhaps a function of a more divided Fed than many have observed.)

Finally, below are The Wall Street Journal's Jon Hilsenrath's relevant post-FOMC comments:

-- LITTLE CHANGE IN THE ASSESSMENT OF THE ECONOMY: The housing sector has "slowed somewhat," the Fed said. That's a downgrade from September when officials said it had been strengthening. The labor market had shown "some further improvement," the Fed said, an ever-so-slight downgrade from the "further improvement" the Fed noted in September. On net, very little change in how officials see the economy performing.

-- FINANCIAL CONDITIONS IMPROVING: The Fed dropped its reference to financial conditions having tightened in recent months, as it noted in September. That's a nod of approval to rising stock prices and the recent drop in long-term interest rates. The Fed also removed a reference to its concern about higher mortgage rates, which have dropped since the last meeting.

-- STILL AN EYE ON TAPERING: The Fed retained language it used in September which suggested officials had an eye on pulling back from their bond-buying program if the economy improved. It noted "underlying strength" in the broader economy and said it chose to "await more evidence" on the economy's performance before adjusting the bond-buying program.

Taken together, the Fed isn't taking a December adjustment to the bond-buying program off the table. But that comes with the strong caveat that it depends on whether the economy is living up to its expectations. As part of that assessment, Fed officials will be updating their economic forecasts in December and will need to make a judgment about whether their projection of accelerating economic growth in 2014 is likely to be met.

The bottom line is that while a January or March 2014 tapering remains most likely, an element of uncertainty (and a possible December tapering) has been introduced.

If, as many of us believe, bond buying has had an outsized impact on the pricing of assets (stocks and bonds), then the market outlook over the balance of the year has grown more hazy and scary.

Happy Halloween from the Fed.

At the time of original publication, Kass had no positions in the investments mentioned.

Doug Kass is the president of Seabreeze Partners Management Inc. Under no circumstances does this information represent a recommendation to buy, sell or hold any security.

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